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Friday, November 23, 2012

W(h)ither China? "The End Of Extrapolation"

Submitted by Tyler Durden:The question whether China will suffer a
"hard" or "soft" landing is, in the long-term, largely irrelevant and
misleading. A far more critical question is whether the period of 10%,
or even 7% annual growth, for the world's biggest marginal growth dynamo
of the past decade, is now over. Read on for the answer.

On November 5, just as the 18th Chinese
Congress was about to elect a leadership that would merely perpetuate
the status quo, in "The Chinese Credit Bubble - Full Frontal" we presented a little known fact:
namely that while China's sovereign debt is whatever the country wishes
it to be (which due to the SOE basis of its banks is really a hybrid of
sovereign and financial debt), one bubble that the country can not hide
is that of its corporate debt level, which has hit the highest relative
to GDP level in the enitre world.

Ten days later Businessweek followed up with "Corporate China's Black Hole of Debt", which contained the following replica chart:And so the cat of China's real debt bubble is out of the bag and out
for general consumption. Yet as promptly as it appeared, it was
forgotten, as a desperate for any favorable economic news punditry
has ignored the fact that economic data coming out of China is merely
for propaganda purposes and consumption by the gullible (not our words,
they belong to China's current Vice Premier and the man who will soon
take the post of Premier, Li Keqiang, who 5 years ago said that "China's GDP figures are "man-made" and therefore unreliable...[most] figures, especially GDP statistics, are 'for reference only,' he said smiling."), and has latched on to the prior month of modestly more favorable, "rebounding" economic statistics. As UBS George Magnus says, "Many people think the downswing has now
ended, pointing to slightly feistier data in September and October for
industrial production, fixed asset investment, retail sales, and
exports, continued high levels of total social financing, and a renewed
rise in corporate leverage." The trivial rebound will soon end but a far
bigger problem will then reemerge: "the short-term outlook for
growth pales into significance against the view that China will continue
to grow at 7-8.5% for the foreseeable future." And herein lies the rub: because while China is currently
experiencing a brief dead cat bounce, a far greater question remains
open: can China reverse its declining GDP growth rate and continue growing at what most realists now perceive as an unsustainable pace. Says Magnus in attempting to provide an answer: "This [...] rests on three critical but questionable propositions:
political will and capacity, the insensitivity of consumption to the
investment outlook, and the nature of rebalancing, itself." Magnus then proceeds to share his vision of whether China can "rise
above" the reality of an economy forced to transition from investment
driven to one of consumption: a vision which is the topic of his latest
paper titled "China: the end of extrapolation." In short, his answer (which at 11 single-spaced pages is hardly
short) is that the party in China has ended. Of course, he is far more
diplomatic:

After a decade or more of turbo-charged growth, the economic model
that drove it has led to deep imbalances, especially as regards the
investment and consumption shares of GDP, significant increases in both
the investment- and credit-intensity of GDP growth, and the distribution
of income between profits and wages. A host of institutional, monetary,
financial, tax and other fiscal arrangements has been developed to
support this economic model. As we will explain below, changing this
model has become of paramount importance if China is to avoid a
disruptive bust in investment in the next 1-2 years, and lapse into a
middle income trap in the medium-term. A change is all the more
important as China’s competitive advantages in the global economy are
slowly being chipped away by rising wage and labour cost pressures at
home, and the development of cheap energy and new lower-cost, advanced
manufacturing technologies in the US, South Korea and other OECD
countries.

The biggest issue for a largely welfare safety-net free China has
been balancing economic growth with broad prosperity. Focusing just on
one, can and will promptly lead to social instability and "rising
pressure":

Social pressures have continued to build with respect to income
inequality, corruption, living and working conditions of migrant
workers, miscarriages of justice and ‘land grabs’ by local government
officials, and air and water quality and environmental degradation.
According to one Chinese sociologist, the number of incidents of unrest
may have been of the order of 180,000 in 2010.

So China has to keep growing at the required pace of 7%+ to keep the
population mostly satisfied. But how, now that as noted above, the
"turbo-charged" growth period is over. And how when the new Chinese
Politburo leaders are even more conservative than the old ones, and even
less willing to force the much required transition from an
investment-driven to a consumption-led model.

The first proposition, following on from the political economy issues
discussed above, is that the government has the political will and
capacity to introduce reforms that lead to both a sharp fall in the
investment share of GDP, and a roughly equivalent rise in the
consumption share by strengthening or introducing important adjustment
mechanisms discussed earlier. But we don’t know yet how strong the
climate for reform in China is, even though there is a popular feeling
that things can’t carry on as before. Some initiatives of political
reform, aimed at restoring trust in the Party by curbing corruption and
‘purifying’ the Party so as to prevent the abuse of power for personal
gain, certainly seem likely. More radical political reform, though, doesn’t look likely.

...

This raises questions about the wider significance of rebalancing,
which means reforms that would abandon the key drivers of the ‘old
model’, including wage rises significantly below productivity growth,
repressed interest rates, a managed exchange rate, and other subdued
factor prices, that is, of land, water, energy, and importantly, of
capital. There is little question that, over a decade and more, a
correction of repressed factor prices, money and capital especially,
would help to generate the resource shift needed to drive a more
household- and private enterprise-oriented economy, and strengthen
resource allocation, efficiency, innovation and total factor
productivity. We can be hopeful that China’s new leaders will reform
gradually in this direction. But intent will count for little in the
face of inertia or a concerted push-back or resistance from others in
the Party and the state apparatus, and it may be prudent to remain
cautious. Remember that fundamental economic reforms are all about
politics that are highly controversial and could, in some respects
perhaps, prove to be of existential significance to the Party.

So while politics is certainly the primary consideration for what is
still largely a centrally-planned economy, an even bigger concern may be
simple math.

The maths are problematic. If investment is 50% of
GDP and the growth rate falls from 15% to say, 5% per annum, consumption
growth has to accelerate from about 8% to an unprecedented 12% per
annum or so if the underlying GDP growth rate is to stay at 7.5%. You
can do the maths of alternative scenarios at leisure, but the bottom
line is that rebalancing requires investment to grow more slowly than
GDP, and consumption significantly faster over an extended period of
time. Otherwise the model isn’t changing.

The more structural reason is that the mechanisms that would allow
consumer spending to strengthen further don’t yet exist, and would, in
any event, compromise the legacy sources of economic growth that have
generated structural imbalances in the first place. For example,
higher wages dent corporate profits and investment; higher interest
rates and a stronger exchange rate help consumers, but to the
disadvantage of companies, whose debt-servicing capacity would be
compromised; pro-household tax, income and social security reforms have
to be financed, one way or another, by companies, or the government.

The issue, specifically in China, is more about the speed of capital
accumulation, and misallocation of capital, given that, uniquely, the
investment share of GDP has been in a range of 40-50% for about a decade
now. Roughly two-thirds of the stock of capital has been built in the
last decade, and half of infrastructure investment since 2000, for
example, has been in transportation projects, many of which serve the
same objectives, and must, for a while at least, be redundant or not
viable commercially.15 And while total factor productivity growth, which
is a measure of the efficiency of capital and labour utilisation, did
rise strongly during the 2000s to about 4% per annum as the
pre-imbalances apex boom gathered momentum, it has fallen back to
around 2% per annum since.

But perhaps the biggest concern is the one that needs no introduction
on this website, and is always summarized simply in what is the real four letter word: debt.

It is well known that China has experienced strong credit expansion.
The growth in regular RMB loans by banks may have slowed down from about
35% in 2009, to a more modest 15% since the middle of 2011, but these
loans capture only half of China’s credit creation. Total social
financing includes also a number of informal financing arrangements,
including commercial bills, trust and entrusted loans, other trust
assets and corporate bonds not held by banks. The last item, in
particular has been growing rapidly, reaching a record RMB 300bn in
October 2012. The different definitions of credit creation are shown in
the following chart, which comes from a research note by UBS China
economist, Tao Wang.

The chart differentiates between regular bank loans, the total of
bank credit and off-balance sheet credit, and total credit in the
economy. As hown, the broadest credit share of GDP has grown from about
150% in 2007 to around 200% in the last 5 years, quite unprecedented
for a country of China’s size.

The rising credit intensity in the economy is also evident in the
changes in the relationship between total social financing and GDP.
Between 2002 when the former data start and 2007, credit outstanding
grew by RMB17 trillion, compared with a rise in GDP of RMB14.5 trillion,
a ratio of 1.2, but since then, credit has soared by nearly RMB61
trillion, compared to a rise in GDP of RMB25.5 trillion, or a ratio of
2..

The biggest expansion in debt financing has occurred in the corporate
sector. Chinese companies’ debt ratios have risen to join some of the
most indebted corporate sectors in major countries, according to Li
Yang, vice-president of the Chinese Academy of Social Sciences.19 At
107%, the ratio is right up there with those of the US, Canada, France
and the Eurozone, though the standardised OECD ratios may not accord to
Li Yang’s definition. But he noted the recent BIS warning that corporate
debt levels over 90% of GDP make companies increasingly sensitive to
changes in income and interest rates, financial fragility and default
risk. These things are liable to weigh on SOEs and other companies, as
GDP growth slows, profits and cash flows weaken and in the wake of
expected financial liberalisation. And, inevitably, tougher times for
orrowers mean tougher times for banks. Most people doubt the officially
estimated 0.97% is a realistic number, and higher loan losses are
inevitable. China is better equipped financially than most to deal with
banking sector loan loss or recapitalisation issues. The point, though,
is that someone has to pay: the cost is almost bound to fall on the
household sector, one way or another, and so where does that leave
rebalancing?

Most ominously, however, is the realization that China too is now
engaging in the developed world's favorite pastime, simply known as
"kicking the can".

Unfortunately, it isn’t really possible for us, or more to the point,
China’s government, to know precisely where the country stands in this
process, any more than people were able to gauge where the West was in
2006, for example. A Chinese Minsky Moment, to coin another phrase, may
not be imminent. In a highly managed economy with dominant state
industrial and banking sectors, the state can deploy policies, and
sources of finance to minimise cyclical fluctuations (as now), helping
to sustain the status quo and lowering perceptions of risk. But this is
the equivalent of ‘kicking the can’ at the risk of a harsher and more
disruptive adjustment later

Finally, Magnus on what happens if instead of the hoped for 8%
trendline growth, China can at best muster half of the previous 10%
growth rate:

The incremental changes in economic rebalancing, and gradual
deceleration in investment spending, which are implicit in the
extrapolations of 7-8% GDP growth, don’t stack up for this scribe. A
more significant fall to 5% over the coming decade – to pick a number –
need not be the cataclysm that springs to mind, unless you’re a
dyed-in-the-wool industrial commodities and commodity currency bull.... A
halving of China’s superlative growth rate would still see GDP double
by 2027, and continue to converge on the US. And since we can imagine
China’s citizens care more about living standards than GDP, a change in
the economic model and in its incentive systems need not be threatening,
if the process is managed well and in a timely fashion. But there’s an
unfortunate truth about changing your development model, which is that
when you get to the point of having to do so, sustainable and stable
growth and prosperity are about politics, institutions and legitimacy. You have reached the end of extrapolation.

Much more in the full paper below, which is a perceptive analysis to
be sure, but really one which puts into words what the simple chart at
the very top of this article succinctly summarizes without a single
word: that the age of credit-driven expansion is over, in the entire
developed world, as well as in China, as China too succumbs to the
tractor beam of peak consolidated (or is that fungible?) leverage.
Because without the ability to create any more debt, and thus money,
out of thin air without the threat of an ensuing debt delinquency,
discharge and default avalanche, there is no more growth.Full George Magnus paper on China:George Magnus China

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Are YOU Involved or Institutionalized? Our belief that the global economic crisis would persist and deepen is being vindicated and current events are now as clear as ever on the matter. Time for all of us to wake up, stand up and be counted or continue to lose all our liberties. Protect your homes and families. The sun will still rise but financial chaos and suffering due to the global fascist banksters' greed and corruption, slaughter due to the MIC's directed world wars in our name etc. is not pretty. We are feeling the effect on our society the size and like of which we have never known.

We are way past being surprised at the blanket suppression of this information by the BBC and main stream media propaganda machines. Information is clearly available elsewhere and unchallenged, accounts for a far more realistic rendition of what we have actually seen and what we continue to see develop, whilst the main stream news put out leaves many confused and bewildered, 99.9% of us wrong footed and the awakened indignant. As we can now see, the apparently 'soft fascist' powers that be aim to block these alternative avenues of information. Book up, "Long Live the Evolution."Feel free to copyme. Angelo Agathangelou.

P.S. The MHRM, are calling out the constant misinformation disseminated by and maintain our open challenge especially to western radical feminists, to point out just one area where government in the UK, Europe or anywhere else in the English speaking world disadvantages women and girls when compared with men and boys, ...the wage disparity myth having long been debunked by serious academics and statisticians. So far this challenge has remained unanswered. Western feminism is obsolete.

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N.B.

These pages exist because we believe information from all perspectives should be aired, they do not necessarily reflect our views unless explicitly stated. We do not intend to cause offense, but we feel there is a need for such a shift in our society that to call it change rather than evolution would be an understatement. A velvet revolution towards living with reality for the individual, the family and society. A revolution towards living within our means and taking responsibility for ourselves, instead of mortgaging the future of our children to bloated leech faux democracy for the benefit of Ponzi 'banksters' and The Military Industrial Complex.